Unfazed by hawks, Bernanke refreshes easy-money message

March 21, 2013|Ann Saphir and Jonathan Spicer | Reuters

(Jonathon Ernst/Reuters)

SAN FRANCISCO/NEW YORK (Reuters) - A crescendo of public warnings from hawkish Federal Reserve officials about the dangers of having a $3 trillion-plus balance sheet appears to have done little to sway the Fed's top ranks.

While Fed Chairman Ben Bernanke on Wednesday signaled a willingness to begin scaling back the U.S. central bank's bond-buying program if the economy continues to improve, he downplayed the program's risks and made clear that he does not expect to begin tightening policy anytime soon.

If anything, it has been the Fed's most hawkish policymakers - those whose concern with inflation trumps their worries about high unemployment - who have shifted their views, coming a bit closer to the central bank's core decision-makers.

Despite a drop in unemployment last month and surprising strength in retail sales and manufacturing, only one Fed official wants interest rates to start rising this year, according to forecasts published by the Fed on Wednesday at the close of its policy meeting. In the previous forecasts in December, there were two.

Indeed, the overwhelming majority of Fed policymakers support continued bond-buying for now and low interest rates until 2015.

And while Fed officials back in December on average saw short-term interest rates at 1.4 percent by the end of 2015, the average based on Wednesday's forecasts was 1.3 percent, suggesting a more gradual policy tightening in the years ahead.

These subtle shifts could come as a surprise to investors after increasingly vocal warnings from a handful of Fed policymakers -- including Jeremy Stein, a Fed governor and Bernanke ally -- that the massive bond-buying could disrupt financial markets and inflate asset bubbles.

The minutes of the Fed's two prior policy meetings had captured what appeared to be a growing angst over the direction of policy. When the minutes became public, longer-term Treasury yields rose as investors scaled back expectations of Fed easing.

"I think the hawks have toned it down a little bit," said Scott Anderson, chief economist at Bank of the West in San Francisco. "They are in the firm minority right now, and don't have much sway on policy action."

The forecasts showed that most Fed officials see inflation at or below the Fed's 2 percent target through 2015.

However, at least one official appeared to countenance a rise in inflation to 2.6 percent, beyond what the Fed has officially said it would tolerate in its quest to reduce unemployment. The forecasts from each policymaker assume an "appropriate" path for monetary policy.

The 2.6 percent forecast, the top of the range of inflation projections for 2015 from all 19 Fed officials, "certainly would be a statement towards de-emphasizing prices and focusing on employment," Anderson said.

STEIN'S SURPRISE WARNING

The Fed on Wednesday said it would continue to buy $85 billion in Treasuries and mortgage-backed securities a month, and it renewed its pledge to keep rates near zero until unemployment falls to at least 6.5 percent as long as inflation stays close to the Fed's 2 percent target.

Bernanke pointed to welcome improvements in the labor market and suggested the Fed could trim its asset purchases should the job market outlook improve. But he also made clear the U.S. central bank is loathe to declare victory too soon.

The jobless rate fell last month to 7.7 percent from 7.9 percent in January, and since November U.S. employers have added an average of more than 200,000 jobs a month.

"We have seen periods before where we had as many as 300,000 jobs for a couple of months, and then things weakened again," Bernanke said at a news conference following the two-day Fed meeting. "So I think an important criterion would be not just the improvement that we have seen, but is it going to be sustained for a number of months."

The Fed's decision to press on with bond-buying, and Bernanke's characterization of its risks as "manageable," puts to rest for now the hand wringing by policy hawks.

Their fretting peaked last month after Stein warned that credit markets could overheat if bond-buying continues. Minutes of the Fed's January policy-setting meeting showed a number of the Fed's 19 officials thought the cost of QE3 might force an end to it before the labor market improves as much as desired.

Beyond worries over the impact on financial markets, the massive money-creation could set the stage for inflation and lead to losses on the Fed's balance sheet, some hawks have argued.

Two - Charles Plosser, president of the Philadelphia Federal Reserve Bank, and Dallas Fed chief Richard Fisher - have called for an immediate tapering of the bond-buying.

But Bernanke and the Fed's No. 2 official, Vice Chair Janet Yellen, have strongly defended the policy, soothing market fears of an early end. Wednesday's decision further eased those fears.

The costs and benefits of the asset purchase program have "drawn a sharper focus since Governor Stein's forceful speech," Citigroup economist Robert DiClemente told clients. "The policy statement did not warn that QE might be halted before there is substantial improvement in the labor market outlook."

Traders now see the first rate hike coming in April 2015, according to futures data. As recently as January they saw the first rate hike coming in late 2014.

For now, low inflation has given Bernanke the leeway he needs to press on with "steady as she goes" easy policy, said Randy Kroszner, a University of Chicago professor and former Fed governor.

"There's really no reason to pull back the punch bowl, particularly when there's no sign of inflation on the horizon."